Michele Bachmann (R-MN) graciously held up a copy of my book Meltdown, which she said she was reading and enjoying very much. She was likewise concerned about the extent of the Fed’s discretionary powers, and the extent to which the taxpayer winds up on the hook for things he doesn’t even know about. I took the opportunity to clarify a point she already understood, but which is sometimes obscured in the shorthand we use: the impact on the taxpayer is really an impact on him in his capacity as a holder of dollars. If the Fed’s arrangements with private firms leave the central bank with lower-quality assets than before, then its ability to carry out its policies while preventing price inflation from getting out of hand is impaired. The Fed’s ability to sterilize its injections – i.e., taking dollars out of one sector of the economy as it injects them into another – is compromised when there is a decline in the quality of the assets it intends to sell to withdraw the dollars. In other words, it can still inject dollars, but it’s now harder to remove them (since its assets no longer fetch as many dollars).

You see the mistake Tom is alluding to here, when people write denunciations of the bailouts and monetary base growth, then say, “Taxpayers are on the hook.” But no, if we’re talking about Fed operations, then it’s not taxpayers per se, but holders of dollar-denominated assets, who are on the hook. For example, the Chinese central bank stood to lose a lot from Bernanke’s inflationary activities. But it’s understandable why Fed critics rally the troops with the cry of “taxpayers!” rather than “Chinese!”